WASHINGTON — A series of fiscal leaders warned last week that federal debt is heading toward record levels at a faster pace than previously predicted, a situation they said requires decisive action to avert long-term consequences.
The admonitions have come in a series of high-profile appearances featuring the director of the Congressional Budget Office, the director of the White House budget office, and a pair of Federal Reserve chairmen - one current, one former. All offered essentially the same message: Get the spiralingfederal debt under control or face the prospect of steep tax increases, spending cuts and economic turmoil.
“The arithmetic is, unfortunately, quite clear,” said Federal Reserve Chairman Ben Bernanke.
To avoid “large and unsustainable budget deficits,” Bernanke said, the nation willbe forced to choose between raising taxes or reducing benefits in the programs that are causing the debt levels to rise, chiefly Social Security and Medicare.
“These choices are difficult, and it always seems easier to put them off - until the day they cannot be put off anymore,” he said. “But unlesswe as a nation demonstrate a strong commitment to fiscal responsibility, in the longer run we will have neither financial stability nor healthy economic growth.”
Bernanke was just one of several high-profile budget watchers who sounded the alarm in recent days aboutthe growing federal debt. They referred to the nation’s long-term bottom line - the overall difference between how much the government spends each year and how much it takes in, as opposed to the deficit from the annual budget approved by Congress.
The scenarios economists foresee to address the debt problem involve politically difficult decisions that likely would result in higher taxes for many segments of society coupled with significant reductions in government programs and services.
It’s a situation already playing out in Greece, for instance, where the government’s effort to reduce its debt by raising taxes and cutting programs has been greeted by protests and strikes.
NEAR-RECORD DEBT LEVELS
All of this renewed discussion comes in the wake of a report last month from the nonpartisan Congressional Budget Office, estimating that President Barack Obama’s current proposed federal budget would increase the longterm debt from $7.5 trillion in 2009 to $20.3 trillion by 2020 - a level amounting to 90 percent of the nation’s gross domestic product (GDP). The report was a follow-up to an earlier one, and it showed the red ink rising even faster than previous estimates.
That would put the debt in the range of its highest point, as a percentage of GDP, which at the end of World War II was 108.6 percent. That meant the government owed more than the nation’s entire economy generated in a year’s time.
A separate study issued earlier this year by a pair of economic researchers, wellknown in financial circles - Carmen Reinhart of the University of Maryland and Kenneth Rogoff of Harvard University - found that a country’s economic growth begins to fall once its debt ratio reaches that 90 percent level.
Meanwhile, one of the leading credit-rating agencies- Moody’s Investors Service - warned last month that the United States could see its current gold-plated credit rating lowered if it fails to bring federal debt under control, something that has never happened since the country was first rated by Moody’s in 1949.
That would result in higher interest rates on the money the United States has to borrow - which would ripple throughout the economy and would ultimately make thedebt even larger, said Thomas Goho, chief economic consultant for Stephens Inc.
“We are truly on a bubble, and that bubble could lead to a downgrade,” said Goho, a former finance professor at Wake Forest University in Winston-Salem, N.C.
And that, Goho continued, could lead to even higher debt levels.
“These things that you would like to do as a society or as an economy are going to be driven out,” he said,citing government spending for everything from defense to foreign aid to education to job training.
“These things are going to be driven out of the budget and replaced by interest on the debt,” Goho said.
At the same time, the difficult decisions that must be made become much harder and more expensive as the debt increases, said Maya MacGuineas, president of the Committee for a Responsible Federal Budget, a bipartisan, nonprofit group that opposes large-scale deficit spending. The prospect of a downgraded credit rating adds a sense of urgency.
“We want to make these decisions while people still think the U.S. is a safe investment,” MacGuineas said.
Ultimately, all of these factors caused by a high debt level can become a self-perpetuating cycle: a high debt causes a lowered credit rating that leads to higher interest rates that make it more expensive to borrow money, which makes the original debt even higher. That could make it harder for the United States to borrow money, which could increase the pressure for the tax increases or spending cuts needed to get the situation under control - the scenario now playing out in Greece.
In addition, the economic recession has exacerbated the situation by resulting in a higher demand for government services and a need for economic stimulus at the same time there has been a reduction in tax revenue.
“It’s a vicious debt cycle that is really hard to get out of,” MacGuineas said.
And it’s an entrenched problem, Goho said, because once that debt is on the books, it’s hard to get rid of it.
“It’s like the person with a credit-card debt of $25,000 who’s making $25,000 a year,” he said. “The probability that they’re ever going to be able to reduce that is very minimal. That’s the situation our country is in.”
TRADE-OFFS
On the heels of those reports, several key financial leaders warned last week of the need to address the longterm federal debt.
On Tuesday, Paul Volcker, a former Federal Reserve chairman who serves as a White House economic adviser, said new taxes may be necessary to address the federal debt. Answering a question from the audience at a New York Historical Society event, Volcker said, according to the Reuters news service, that “if at the end of the day we need to raise taxes, we should raise taxes.”
Those comments were followed on Wednesday by Bernanke, the current Federal Reserve chairman, who offered his debt warning to the Dallas Regional Chamber in a speech that also raised the prospect of increasing taxes.
“The economist John Maynard Keynes said that in the long run, we are all dead,” Bernanke said. “If he were around today he might say that, in the long run, we are all on Social Security and Medicare.”
And that, he continued, is the crux of the problem - finding a way to pay for those government-run programs that ensure basic health-care and living needs for older Americans while also reducing the debt so those programs will be around for future generations.
“Inevitably, addressing the fiscal challenges posed by an aging population will require a willingness to make difficult choices,” Bernanke said.
On Thursday, Douglas Elmendorf, who heads the Congressional Budget Office, offered a similar assessment while speaking at a breakfast sponsored by The Christian Science Monitor.
Elmendorf agreed that the nation’s fiscal course is “unsustainable” and that fundamental changes are needed because the problem “cannot be solved through minor tinkering.”
He echoed Bernanke by saying that will mean spending cuts or tax increases “that are directly visible to Americans” and as a result “the choices will more directly affect people.”
Later Thursday, Peter Orszag, director of the White House Office of Management and Budget, weighed in on the federal debt.
“We’d like to get ahead of the problem,” Orszag said at the Economic Club of Washington. Otherwise, he added - agreeing with the week’s other assessments - Americans will be looking at an “excruciating set of trade-offs” in the future.
With attention to the debt increasing, MacGuineas believes momentum for addressing the issue is becoming unstoppable. “The genie’s out of the bottle,” she said.
But the sheer size of the debt combined with the complexity of the financial and economic issues involved make it difficult for MacGuineas and other budget watchers to convey what it means and why it matters.
MacGuineas and Goho agree that if the debt continues to grow, and steps are not taken to bring it under control, it will have an impact on quality of life.
“Picture every one of your older relatives moving into your living room because their savings have eroded,” MacGuineas said.
Most economists agree it’s still too early in the economic recovery to begin taking the big steps needed to address the long-term debt.
In his speech, Bernanke said “a sharp near-term reduction in our fiscal deficit is probably neither practical nor advisable.” But, he added, “nothing prevents us from beginning now to develop a credible plan for meeting our long-run fiscal challenges.”
Front Section, Pages 1 on 04/11/2010